Bank, Heal Thyself

It's hard to get too far into a discussion about what to do with the nation's large and troubled banks without someone bringing up Japan (or Sweden; they're both popular). In debates over bank policy, Japan has taken on talismanic properties, making it a sufficient answer to just about any difficult question. Why shouldn't we prop up struggling banks? Japan. Why should we nationalize insolvent institutions? Japan. What will happen if we ignore the lessons of Japan? The dreaded Lost Decade.

The basic idea is this -- failure to properly resolve a banking
crisis can leave an economy with zombie banks, insolvent but still
operating, which do not lend and therefore prevent the economy from
recovering fully. Given the situation in which we find ourselves,
namely, one in which the government has determined to prop banks up
rather than nationalize them or let them fail, this is fairly
distressing.

But is it true? In fact, it seems that Japan's
banking crisis isn't nearly as analogous to America's as you might
expect. As John Hempton has explained,
Japanese banks had tons of savings, few loans, and slim margins -- just
the opposite of the big banks here. And they didn't impair recovery by
failing to lend, but by continuing to provide credit, for political
reasons, to large industrial firms that were in terrible shape. This
was the zombie relationship. Japanese savers poured money into the
banks, the banks rolled over old debt to busted property companies and
industrial firms, and so necessary shifts in the economy never took place.

As James Surowiecki notes,
political involvement in the banking system in America has not led to a
similar outcome -- the banks aren't being told to keep sinking firms
afloat. The results have been plain for all to see; old industrial
enterprises have been hammered, as have firms tied up in the housing
boom. The destruction in "creative destruction" is taking place,
leaving plenty of room for creation later.

And that's where the
analogy between Japan and America becomes more apt. Paul Krugman, for
all his insistence on nationalization, has argued
quite forcefully that it was an export boom rather than a banking fix
that finally saved Japan. The worrying thing for most economists is
that America is unlikely to export its way out of recession -- that's
just not how our economy is structured at present -- and it isn't clear
where else growth might sprout. Consumption has traditionally been our
main engine of growth, but consumers remain saddled with debt and are
unlikely to pull the economy out of its doldrums.

In our story,
the banks are largely a side issue, dependent on margins to
recapitalize themselves which they can only enjoy if the economy begins
growing strongly again. But after decades of neglect of the real
economy, it's just not clear how strong growth might quickly resume;
too many workers simply aren't prepared to find employment outside of
manufacturing or construction.

It's important to understand
this, because there are ways the government can address structural
issues. It will be politically difficult to spend money on the
appropriate policies, however, so long as there are economists out
there loudly demanding that we keep our powder wet for the bank
nationalizations that will eventually be necessary.

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Ryan Avent is The Economist's economics correspondent and the primary contributor to Free Exchange, an economics blog